Restaurant stocks have been getting hammered lately, and for good reason.

Whether their results have flat lined or deteriorated, Wall Street has not taken any prisoners, for better or worse.

One of the last shoes to drop finally happened on Friday September 12 when Chipotle Mexican Grill(NYSE: CMG)(NYSE: CMG-B) had one of those nice little “Business Updates” that we’ve all come to love so much around here, whereby the company lowered Q3 guidance, and all but admitted that they are starting to really struggle as a result of outside forces.

The good news this time around was that with deteriorating macroeconomic conditions and company-specific issues, I knew we would be getting a better entry point somewhere down the line on shares of Chipotle’s stock.

So is Chipotle, a well-run, dynamic restaurant company that operationally is best-in-class, a good candidate for a rebound from here?

Does the 20% stock price plunge on Friday, and the further decline from $150 a share earlier this year to the now more reasonable $57 per share ($53.50 for the “B” shares, more below) present a great buying opportunity, or could this be just the beginning of Chipotle finally joining the recession party?

New to the Chipotle story?

Chipotle Mexican Grill owns and operates 775 “fast-casual” Mexican restaurants and offers a focused menu of burritos, tacos, burrito bowls (a burrito without the tortilla) and salads made from fresh, high-quality raw ingredients, prepared using classic cooking methods and served in a distinctive atmosphere.

Chipotle adheres to what they call Food With Integrity (FWI), whereby Chipotle seeks better food not only from using fresh ingredients, but ingredients that are sustainably grown and naturally raised with respect for animals, the land, and the farmers who produce the food.

Chipotle’s ultimate goal is to be able to serve only organically raised and grown food in all their restaurants.

Take Me Back…

Chipotle started off as a stand-alone company, which was then purchased by McDonald’s Corp. (NYSE: MCD), before being spun off almost 2 years ago as a stand alone company to much fanfare in an overpriced, overhyped debut.

Shares were offered at $22, and doubled on their first day of trading, and never looked back, rising to a peak of $150 per share right around late 2007/early 2008.

Since then the shares have slowly fallen, and took a nosedive Friday, to their now more reasonable $56.70 per share.

The question for us becomes, is Chipotle now at an attractive risk/reward level, in spite of the consumer malaise and slowing economy, or do we have a substantial amount of pain left to suffer?

Too Hot To Handle

Since the IPO I’ve been watching Chipotle experience rapid growth, strong margins and amazing cashflow that has allowed the company to fund the opening of new stores without tapping into any debt or financing.

In fact, Chipotle seemed to justify its lofty price by crushing analyst’s estimates quarter after quarter, and hasn’t reported anything weaker than 20% profit growth in any quarter since coming public.

That, I’m happy to say for our sake, has now changed.

With the announcement on Friday that the down economy and rising food costs are finally catching up to the high-flying company, Chipotle now expects earnings to come in “slightly below” last year’s Q3 profit of $.62 per share.

This would make the first time as a public company that they have lowered expectations, and marks a turning point in the Wall Street darling’s rapid ascension to it’s lofty and overvalued levels.

I am a regular Chipotle patron, and knew there was trouble in the water as traffic seemed to be slowing in my anecdotal visits to the restaurant.

In addition, prices out here in California shot up unexpectedly to a level that might turn off some customers.

Some menu items rose more than $1.00, which amounts to a 15-20% price increase depending on what you order.

I’m sure most people don’t come to Chipotle to save money when eating out, as they are on the more pricey side of the “fast-casual” market, but nonetheless, I knew right then and there that the stock would be coming down, and all I had to do was wait it out.

Sure enough, Chipotle all but confirmed this saying in their press release:

“Based on third quarter results to date, the impact of the weakened economy has been greater than anticipated resulting in further sales deceleration leading to comparable restaurant sales in the low single digits for the third quarter of 2008.

The combination of a weak economy as well as food costs rising faster than expected during the quarter will result in the Company’s diluted earnings per share for the third quarter of 2008 being slightly below third quarter 2007.

The Company is working on national pricing plans for the fourth quarter of 2008 to offset rapidly rising food costs.”

What this mysterious “national pricing plan” might be is a little troubling to me in light of the fact that Chipotle has ALREADY raised prices, pretty significantly in fact, in some locations around the country once this year.

Now they are going to ask patrons to dip a little deeper into their pockets for some spare change to make up the difference.

So What Does This Mean for the Stock?

It’s obvious that although Chipotle is a best-in-breed restaurant company, the stock was just not reflective of the current economic conditions and the fact that no matter how wonderful a restaurant is, and believe me, Chipotle is pretty amazing, that weakness had to be accounted for, and up to now, was not.

The question for us then becomes, is today’s stock price a good entry point seeing as it is the lowest that Chipotle has traded for almost since it became a public company?

Let’s look at some quick reasons why now is NOT a good time to buy shares of Chipotle:

Further declining sales more than likely: I believe that this is just the tip of the iceberg.

As mentioned previously, Chipotle has always crushed analyst’s estimates and this trend has now been soundly broken 2 out of last 3 quarters when they missed by $.02, and $.01 respectively.

Normally this is not a big deal, but in the context of Chipotle usually crushing analyst’s estimates by anywhere from $.04-.15 per share every single quarter since they came public, missing even by a few pennies is a big deal.

Taken further, with Friday’s announcement, Chipotle will now have missed analyst’s earnings estimates in 3 out of the last 4 quarters, with analysts projecting this quarter’s earnings at $.72, which Chipotle lowering to about .$60 per share, or a $.12 miss.

This is a disturbing trend.

Remember the old saying: “Ignore deteriorating business fundamentals at your own risk.”

Current valuation still not attractive: Even with Friday’s 20% haircut, Chipotle still trades at a forward P/E ratio of 22.96 (using lowered analyst’s estimates of $2.47 EPS for 2008 vs. $2.61 on Friday).

This compares to the industry average of about 15 or so.

Further, Chipotle’s price to sales ratio stands at a staggering 1.53 when the industry sits anywhere from .5-.8 depending on which restaurant type you are looking at.

I just don’t see the downside protection here, especially if Chipotle lowers their earnings guidance further for the year when they do report earnings and have to revise them down substantially as a result of higher input costs and slower sales.

Higher valuations are fine for companies that are best-in-breed as Chipotle is, and are growing faster than their peers, but that growth has now been called into question especially in terms of profits, if not pure revenue (more below).

Declining Same Store-Sales: Earlier this year, Chipotle’s same-store sales guidance was for the high single digits.

As of Friday that has now been reduced, for the second time, to the mid to low single digits.

Opening new restaurants at a break-neck pace: At the same time that the economy is presenting Chipotle with some serious headwinds, they are still anticipating opening a total of 130-140 new locations this year.

Is it wise or prudent to open so many new locations, especially in light of deteriorating fundamentals and higher food costs?

Shouldn’t Chipotle real in a little bit of that growth, make sure that they are still cash flow positive, and able to fund operations till things stabilize?

Are they overreaching in bad times to please shareholders?

High short interest: Chipotle’s short interest has steadily risen to about 35% of the shares outstanding.

There is a large bet against this stock, and so far, the shorts have been right in predicting the stock’s move downward as well as the deteriorating fundamentals and market conditions.

Let’s look at some quick reasons why now IS a good time to buy shares of Chipotle:

Lower stock price, never cheap: Chipotle has never been a “cheap” stock.

High growth and best-in-breed operators like Chipotle that have shown operational excellence and have a market cornered always deserve that premium.

With shares trading around a .91 PEG ratio using analyst’s estimates of 25% 5-year EPS growth, Chipotle looks like a downright steal at these levels.

We are also getting a stock that is trading around the price where it went public and close to it’s lowest levels ever, while at the same time getting almost 2 more years of operational excellence and execution.

I would urge caution however, as I believe that analyst’s 3-5 year EPS growth rates are still too high, and with them, their EPS and sales outlooks.

If these fall further, today’s share price will look in retrospect like the classic “value trap”.

I would be much more comfortable with a growth rate in the high teens, and an EPS estimate to match that, say something around $2.40 or less which would represent only a 13% EPS growth rate year over year from 2007-2008.

Along with that, the long term growth rate will also need to be ratcheted down for me to feel more comfortable that Chipotle provides an excellent risk/reward scenario.

We’re close, but not there yet in my opinion, especially with the “pricing initiatives” that Chipotle is going to reveal in about a month or so.

Same-store sales STILL positive: Well, if this was a negative above, it surely needs to be a positive here.

Same-store sales are still positive!

That’s amazing news in this environment, as there aren’t too many restaurant companies or chains that can make that claim.

That begs the question: if Chipotle is able to keep same store sales positive in the absolute worst conditions we’ve seen in a long time, what will they look like when things improve?

New restaurant openings: Well, just as this could be a negative, it also has to be seen on the flip side as well, as a potential positive.

You see, if Chipotle is able to fund new store openings from their present cash flows, and keep opening new stores despite macroeconomic conditions, that bodes extremely well for the future when things do turn around and Chipotle has these restaurants in place to take advantage of the uptick in consumer spending when it happens.

Already we are seeing a pullback in commodity prices and consumer staples.

If this is able to trickle down further to the bottom line for consumers and Chipotle, having a brand new store base to pull from will only benefit them as they expand further in the future and leverage their business model even more.

This also bodes well for their top line numbers and continued sales growth, but I caution as I stated above, this might be more detrimental than beneficial.

Continued operational excellence despite trying times: There has to be a tipping point where you have to separate bad management and deteriorating fundamentals.

I believe we could be at that point now with Chipotle.

There’s only so much management, even stellar management like Chipotle’s, can do in bad times.

You can only curtail costs so much, lock in food prices so much, and protect yourself in spite of the falling knife of economic forces only so much before there’s nothing left to do and you are cornered.

I do think that management should curtail some of their expansion plans this year and conserve their cash and concentrate on the business they have and make sure it is stable, but aside from that, Chipotle’s management team has taken all the lessons learned from McDonald’s and produced an excellently run company that caters to those looking for healthier alternatives to fast food made with mostly natural and organic ingredients.

Bottom Line

I have posed both sides of the equation for you, but the ultimate decision is yours.

I have been watching Chipotle’s stock since the IPO and never bit into the hot Jalapeno pepper because it was just to overvalued and still very well might be.

What does look to be happening however, is that Wall Street is finally ratcheting down its expectations for the company to a level that makes much more logical sense, and might present investors with an opportunity to once again dip their toes into shares without the downside risk being as prevalent as it was before.

I’ll be doing more due diligence on the story to determine if purchasing a small position here would be prudent, but suffice it to say that Chipotle has finally entered onto my radar screen as a stock and company we can invest in for the long term, that also presents us with a great entry point to protect us on the downside.

I did not say guarantee us no downside.

I feel that further reductions in analyst’s estimates and/or the company’s own estimates might be forthcoming and warranted based on overall trends.

We might be closer to the bottom than the top, but that certainly doesn’t mean we are there yet.

Buyer be cautious, but prudent.

One more thing: Make sure if you do purchase shares of Chipotle, you buy the “B” shares: NYSE: CMG-B.

They have 8 times the voting power of the “A” (NYSE: CMG) shares, and are 5% cheaper, but are no different than the “A” shares.

This discrepancy used to be as large as 15%, but has since narrowed.

Either way Wall Street is giving you a discount for no reason at all, so I say never look a gift horse in the mouth.

Stay tuned as I’ll be revisiting the Chipotle Mexican Grill story and might pick up some shares as events warrant and I learn more.